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Orion Capital Management are an investment advisory company and fund of funds manager. Eurekahedge talks to Peter Rup, the Fund Manager for the Orion Constellation Partners LLC Fund.

Interview with Peter Rup

What is the difference between your approach to hedge fund selection and other fund of funds? Essentially, what is your edge?

Orion is a multi-strategy fund that differentiates itself through its unique, economic cycle-based approach to hedge fund strategy selection. Orion believes that not all hedge fund strategies perform optimally in all stages of an economic cycle. In this regard, hedge funds are no different than any other asset class. Based upon our experience, strategy allocation is more important that manager selection and the key driver of returns.

Our starting point in portfolio construction, therefore, is strategy allocation. We analyse the economic condition of the U.S., Europe and Asia. We review about 100 economic indicators a week. We look at trends to determine which geographical regions and which hedge fund styles will be the best performers as well as which styles will be underperformers.

Orion's proprietary asset allocation process analyses a typical economic cycle along two dimensions: growth rates and interest rates. Accordingly, cycles can be segregated into four distinct quadrants and begin in Stage I, where the economic activity is low or weak and the monetary policy is accommodative. As economic activity increases the cycle continues clockwise until it terminates in Stage IV where the economic activity is being slowed by restrictive monetary policy. As quadrants change so change the hedge fund strategies that will perform optimally in that environment. This analysis is performed for three geographic regions: US, Asia and Europe.

The process developed for the Kaufman Family Internal FOF is a culmination of over 15 years of experience that Peter Rup has in managing investments in hedge funds as well as managing internal macro hedge funds for his clients.

Equity markets have performed well recently. How has Orion Constellation Partners LLC Fund performed over the last few months? Is it harder to attract investors in bull markets?

As of 11/30/03, Orion has recorded a year to date performance of +11.00%, net of management and incentive fees. Orion has also recorded 13 positive months in a row. Orion's 12 month Sharpe Ratio, utilising monthly returns from December 2002 to November 2003, is 4.88, which is higher than the Sharpe Ratio of 97% of the fund of hedge funds in the Pertrac Database. While a multi-strategy hedge fund of funds might be considered a substitute product for a long-only equity position by the early adopters of hedge funds - high net worth individuals - the product is becoming increasingly important in the far larger institutional world as the "portal" by which most institutions will take there alternative exposure. To an institution a product like this should never be thought of as a substitute for a long-only equity product. The risk/return parameters of a hedge fund of funds make it an intelligent addition to a well-diversified portfolio and will only enhance its efficient frontier.

How often do you visit managers and, on average, how long do you take to make an investment decision after 'discovering' new funds?

With regard to our existing managers we visit telephonically once a month to ascertain exposure, leverage, assets under management and geographic exposure. At least once a year we physically visit each manager. We have developed a strategic relationship with many of them as they are as interested to hear from us about the global economy as we are to hear from them as to how their strategies are faring. With regard to potential managers, we are constantly looking to identify new managers, and conduct 20-30 visits per year, both in-house and at the managers' offices. Since our relationships with managers are strategic and not transactional, we usually have at least a six-month review before hiring new managers.

Do you perform economic analysis of the markets where the hedge funds invest and if so who does this? Who are the other key members of the team?

Economic analysis of underlying markets is the key competitive edge of Orion Constellation Partners. Therefore, we invest more time and effort into economic analysis than other fund of funds. Peter Rup heads this effort, as Chief Investment Officer of Orion, and Co-Director of Investments of the Kaufman Family LLC, and is assisted by two analysts.

How many funds do you hold and what do you see as the optimal number of hedge funds in a portfolio. How many Asian hedge funds are in your portfolio?

Orion currently holds 15 funds. We consider this to be the optimal number of funds to achieve the best risk-adjusted diversification, and this view is supported by considerable empirical and theoretical industry analysis. Over the past four years, we have had as much as 25% exposure to Asian assets, as opposed to funds.

This is a relatively large % of your portfolio for a global fund of funds? Are you finding more favourable returns from Asian-focused managers?

Distressed debt in this region has been a significant contributor to our performance over the past few years. That being said we are only exposed to Asian NPL's which are collateralised by non-Asian assets so exposure is perhaps overstated. Deflation risks make Asian collateral difficult to hold. Our relative outlook for 2004 would cause us to overweight the region but the truly opportunistic areas in Asia are emerging markets which we take very little exposure to. These countries can carry incalculable political risks and until such time as we can determine a way to alleviate that problem we are unlikely to take significant exposure.

Do you invest in start ups? If not, why not? Are there any other requirements to manager selection?

Orion does not invest in start-ups. Our requirements for consideration are:

Minimum three year live track record with consistent out-performance relative to an underlying style;

Minimum of $250 million in assets under management;

Sustainable edge in their strategy;

Separation of trading/risk management functions.

We tend to invest in strategies with a fair degree of predictability/link to economic cycles. We also exclude strategies where we have no knowledge as to how managers generate their returns, e.g. CTA's.

With our stringent criteria, this provides us with a universe of about 350 to 400 managers.

How often do you revaluate your portfolio?

Orion's portfolio undergoes a major rebalancing once every two to three years as we shift economic quadrants. While within a quadrant the portfolio requires rebalancing on an annual basis to adjust weightings. Accordingly, fund rebalancing is a dynamic process. It is accomplished as soon as practicable given the restrictions imposed on withdrawal of capital by the underlying Portfolio Managers.

Why do you think investors should invest in a fund of funds? How would you persuade experienced investors that paying performance fees twice is a good thing? As mentioned before, a well-balanced, well-managed multi-strategy fund of funds has extremely favourable risk/return parameters. The better performers in this space have been able to generate 1000BP over the cash rate with about half the volatility of a long-only equity posture. A product like this significantly enhances one's efficient frontier. If it is evaluated in this fashion the benefit is obvious. A fund of funds is not an efficient substitute for a long-only strategy in any asset class. In the case of Orion we provide a significant value proposition with our dynamic allocation "process". We don't sell ourselves on an "access and diversification" basis like most other fund of funds, which is worth perhaps 50BP a year. We provide that service as well but we feel our fees are justified by the former and not the latter. Bottomline - low fees infer low value added. What should be relevant to an investor is net-net performance and if you are not receiving superior performance on that basis you should look elsewhere, irrespective of fees.

What are your views on passively managed index fund of funds and capital guaranteed fund of funds? Do you see these new products as a threat to more traditional, actively managed, fund of funds? The market is always efficient in that it will provide products to meet demand. Major investment banks are rushing to the market with their fund of fund offerings but have a major problem in differentiating themselves from all of the other "me-too" products out there. Capital guaranteed fund of funds is a good example of differentiation but serve what I believe will only be a small market niche. This type of fund appears to be a European phenomenon more than anything else. Passively managed index fund of funds will also find a following but once investors understand the imperfection and bias inherent in the construct of the benchmark indices they will realise that the returns that these products produce are inferior. I believe the average investor would be surprised to find that a simple "equal weighted" portfolio construct of hedge fund strategies has historically substantially outperformed both the Tremont and HFRI Indices. So why pay someone to manage an index-linked portfolio when you can easily outperform it yourself? Finally, most of the existing FOF products are what I refer to as "first generation" in that they meet the diversification and access needs of the early adopters - high net worth individuals. The far larger opportunity is to provide access for institutions, endowments and pension funds in the world of alternatives which they have very little sophistication in. They have very specific risk/return profile needs which will not be met by a "shrink wrap" /plain vanilla fund of funds offering out there today. The next generation funds will provide customised risk/return profiles that, when added to a portfolio, will optimise a far larger asset pool.

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